Knock-Out Option

AAA

DEFINITION of 'Knock-Out Option'

An option with a built in mechanism to expire worthless, should a specified price level be exceeded. A knock-out option sets a cap to the level an option can reach, in favor of the holder. As knock-out options limit the profit potential for the option buyer, they can be purchased for a smaller premium than an equivalent option without a knock-out stipulation.

INVESTOPEDIA EXPLAINS 'Knock-Out Option'

For example, an option writer may write a call option on a $40 stock, with a strike price of $50 and a knock out level of $60. This option only allows the option holder to profit up to $60, at which point the option will expire worthless, thus limiting the loss potential for the option writer.

Knock-out option are considered to be exotic options and are primarily used for commodities and currency options.

RELATED TERMS
  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Option

    A financial derivative that represents a contract sold by one ...
  3. Vanilla Option

    A financial instrument that gives the holder the right, but not ...
  4. Knock-In Option

    A latent option contract that begins to function as a normal ...
  5. Forex - FX

    The market in which currencies are traded. The forex market is ...
  6. Rebate Barrier Option

    A financial derivative product that will automatically expire ...
RELATED FAQS
  1. What are the main risks associated with trading derivatives?

    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>
  2. How can an investor profit from a fall in the utilities sector?

    The utilities sector exhibits a high degree of stability compared to the broader market. This makes it best-suited for buy-and-hold ... Read Full Answer >>
  3. What is the difference between derivatives and options?

    Options are one category of derivatives. Other types of derivatives include futures contracts, swaps and forward contracts. ... Read Full Answer >>
  4. How are rights distributed in a rights offering?

    In a rights offering, rights are distributed to shareholders based on the number of shares they already own. What Is a Rights ... Read Full Answer >>
  5. What risks should I consider taking a short put position?

    The risks to consider before taking a short put position are the odds of sustained weakness in the asset price and a spike ... Read Full Answer >>
  6. What happens if a software glitch fails to execute the strike price I set?

    If you've ever suffered the frustrating experience of having an order not filled or had a strike price fail to execute because ... Read Full Answer >>
Related Articles
  1. Options & Futures

    How To Avoid Closing Options Below Intrinsic Value

    To get the best return possible on your options trading, it is important to understand how options work and the markets in which they trade.
  2. Investing Basics

    Pin Down Stock Price With Real Options

    How can you assign a value to what a company may do with its business in the future? We explain how it works.
  3. Options & Futures

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
  4. Options & Futures

    Options Basics Tutorial

    Discover the world of options, from primary concepts to how options work and why you might use them.
  5. Options & Futures

    Going Long On Calls

    Learn how to buy calls and then sell or exercise them to earn a profit.
  6. Investing Basics

    Explaining Gamma

    Gamma is a measurement of how fast the delta of an option’s price changes after a 1-point movement in the underlying security.
  7. Economics

    Will the Selloff in China Hurt the Global Economy?

    Though China is the world’s second largest economy, its volatility in the stock market is unlikely to have an impact on the global or Chinese economy.
  8. Investing

    Looking To Begin Trading In The Stock Market?

    If you are a new trader, we explain the differences between penny stocks and options so you can make the best decision for your personal trade plan.
  9. Investing Basics

    How Does Delta Hedging Work?

    Delta hedging is a derivative trading strategy that attempts to reduce -- or eliminate -- the risk caused by price changes in the underlying asset.
  10. Options & Futures

    Tesla Stock Too Expensive? Trade Tesla Options

    Tesla Motors is trading around $260 a share, making it too expensive for many investors. Options offer a low-cost way to trade in Tesla.

You May Also Like

Hot Definitions
  1. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  2. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  3. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  4. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  5. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
  6. Touchline

    The highest price that a buyer of a particular security is willing to pay and the lowest price at which a seller is willing ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!